Every Republican candidate swears up and down, backward and forward, that tax cuts create jobs. Especially tax cuts for the rich. Also that tax hikes are job destroyers, just like high wages and benefits. Is that true? Is it false? How do taxes and jobs interact? Let's try some thought experiments to figure it out.
Let's say you give one million consumers $1,000 each. You also have 1,000 entrepreneurs (those most-loved of all creatures), but you give them nothing.
Do you think that:
A: None of the entrepreneurs will do anything new?
B: Some of these entrepreneurs will figure out ways to sell additional goods and services to the one million who have an extra grand to spend? And they will not stop until they've gotten every nickel?
If you picked B you've sided with the New Deal and its successors. The simplistic $1,000 symbolizes Social Security, unemployment insurance, free education, support for unions, prevailing wage laws, Medicare, Medicaid, Obamacare, and the rest.
There are a lot of people who think that's bad economics—especially if you do it by taking the money from the rich or by preventing them from taking it from working people in the first place. That it would be way better to flip it around. Like this:
You have the same 1,000 entrepreneurs. You give them each an additional $1,000,000. You have the same 1,000,000 consumers. You give them each $0. Zero, nothing, nada. Let us assume, for simplicity's sake, that the 1,000,000 ordinary folks are already maxed out. They've spent everything they had before they were placed in the thought experiment.
According to this theory the entrepreneurs will create all sorts of goods and services. The 1,000,000 ordinary folk will be so excited that they will conjure up new ways to obtain funds to buy the new goods. That is, in essence, supply-side economics.
Can thought experiments actually be useful?
Einstein loved them (maybe because, for him they were gedankenexperimente). They took him first to the theory of special relativity and then to general relativity. It's how we've changed from imagining that gravity is a mysterious force of attraction that pulls objects with mass toward each other to imagining space-time as a continuum that can be warped by mass, which, in turn causes anything in motion—even if, like light, it doesn't have mass—to move along the altered shape.
Thought experiments are very common. Political campaigns are stuffed with them. Here's John Kasich: "To grow jobs requires tax cuts"—note the "requires," like a law of science, and then the reasoning—"because that sends a message to the job creators that things are headed the right way. If you cut taxes for corporations, and you cut taxes for individuals, you're going to make things move." All the candidates for the Republican presidential nomination, indeed, probably all Republicans, lots of economists, and even many ordinary people, agree with this idea.
How do we separate thought experiments into the good, the bad, and the ugly? The good ones are prompted by facts that don't fit the prevailing view and which can then be borne out by actual experiments.
So do the facts prompt the tax-cuts-create-jobs theory?
Let's look. Obviously our population has grown over the years, so quantitative numbers of jobs created won't be to scale across time. The best metric is the percentage increase in jobs created.
Here are the big tax cutters and the percentage increase in jobs on their watch. Lyndon Johnson cut taxes 3.9%; Ronald Reagan, first term 1.43%, second term 2.69%; George W. Bush, 0.01%, and 0.23%.
And yet the biggest increases in jobs came under presidents who raised taxes: FDR (4.97%, 2.53%, 5%, 1.61%); Bill Clinton (2.64%, 2.33%); and Obama (1.99%). In sum, every president who raised taxes had better job creation numbers than those who lowered them.
Some details are worthy of note.
The first big tax hike of the Roosevelt era, a jump in the top marginal rate from 24% to 63%, was actually enacted in 1932, the year before he came into office. Roosevelt would raise rates again in 1936, 1941, 1942, and 1944. The comparatively anemic rate of job growth in his fourth term actually coincides with a slight cut in the top rate from 94% down to 91%.
Reagan's big tax cuts were in his first term. Then he had several tax hikes. The job creation record is better in his second term after the tax hikes. Reagan's record is always compared to the "terrible" economy under Jimmy Carter. But Carter's rate of job growth, 3.06%, was greater than in either of Reagan's terms.
Then there's Obama. His job creation rate is his first term was a pretty lame 0.25%, very nearly as bad as Bush's. The reason only one term is cited above, is that Obama's tax hike—actually letting the top end of the Bush cuts expire—only came in 2012, his second term. Also, the number of government jobs, federal, state, and local, declined under Obama. So even with the public jobs subtracted from the increase in private sector jobs, they still increase after the tax hike.
Here's a thought experiment.
If, in fact, more jobs are usually created after tax hikes than tax cuts, why do so many politicians and economists say the opposite? Is it because the tax cuts they are referring to are for the rich and the rich pay them to say so?
Another thought experiment about the 1,000 entrepreneurs with an extra $1,000,000 each and the 1,000,000 consumers with nothing more to spend:
It is the nature of these entrepreneurs, their helpers, assistants, hirelings, to want to use their money to make more money. What will they do?
A. The entrepreneurs will sell the consumers' money. That is, they will find ways to give them credit. So the customers will pay for the money on top of paying for goods and services.
B. Getting an extra $1,000,000 feels very good. The entrepreneurs will try to make it happen again. If it came through busting unions so that workers no longer shared in increased productivity, they will keep pushing compensation down. If it came by keeping more due to tax cuts, they will invest in politicians who will give them more tax cuts.
C. They will buy and sell money to each other, with ever new and exciting financial instruments that are based less and less on actual goods and services, creating huge bubbles.
The big argument for cutting taxes, especially on the rich, is that past a certain point it discourages work. The classic, and one of the most colorful examples, comes from Ronald Reagan himself. He'd make two pictures a year, but income from a third on top of that would have been taxed at the top marginal rate, about 90% in those days. He said, "Why should I have done a third picture, even if it was Gone with the Wind? What good would it have done me?" and he preferred to "loaf" around.
Here's the thought experiment.
If taxes had been lower and Ronald Reagan had made three pictures a year would the movies of the forties and fifties been better for it?
If we had more of Bedtime for Bonzo, The Voice of the Turtle, The Girl From Jones Beach, Juke Girl, Cattle Queen of Montana, would the world have been a better place?